The medium of spread betting works entirely differently from most other trading styles, and has a number of innovative and unique quirks that set it apart from more conventional instruments, this guide is design to help you to get your head around spread betting. Financial spread betting is not so much an investment as a speculation, calling a particular direction in the movement of a market to profit directly from the broker.
When a trader invests in the stock market, he buys shares in one or a number of listed companies, having reasoned that external market factors combined with business strategy are likely to lead to an increase in value over time. This increase in value, combined with an ongoing dividend to reflect the trader’s share of the company’s ownership is where the money in stocks and shares is to be made, and the security of a tangible, valuable asset in the form of a share is sufficient to slim down the risk profile.
Spread betting (UK trading instrument), on the other hand, operates on an entirely different principle. While to think of spread betting as gambling isn’t always helpful, it is perhaps a valuable lens through which to analyse the theoretical structure of what spread betting is and how it works. With spread betting, the transaction being entered into when you trade on a company’s shares is not a share transaction. There is no transaction per se, and no change of ownership of any tangible asset – simply an agreement between trader and broker to enter into a wager on set terms, based on the outcome of some underlying market.
As such, spread betting can be equally deployed as a mechanism for speculating on sports, political outcomes, TV or just about anything that can be measured – for the operation of the model, there is no need for anything financial or economic, nor even for anything predictable or controllable. Financial spread betting is a popular sub-niche of the wider spread betting industry because the markets can be studied and reasoned logically, and while this isn’t a pre-requisite for successful trading, it is the condition that sets financial spread trading aside as more akin to a trading (as opposed to gambling) activity.
Financial Spread Betting At A Glance
The wager is thus: the trader will ‘buy’ or ‘sell’ a market depending on whether he thinks the market will move up or down, on the understanding that the broker will pay out on successful calls and will be paid to an equal extent on failed positions, to varying extents depending on how heavily the market moves over the lifetime of the trade. This taps in to an important, often fatal element of human psychology – the temptation to weather rough times in the hope of a future improvement. With spread betting, both profits and losses are uncapped, meaning traders will have to decide when best to accept either a profit or a loss.
Bets are offered on a variety of markets and indices, which are used merely as a raw numerical basis for the wager. If the market rises beyond the price at which the trader ‘bought’ the position, the trader wins – end of story. It is this simplicity in part which makes spread betting such an attractive trading opportunity.
Markets are quoted by the broker on the basis of spreads, which indicate the range through which the underlying market or index might be expected to move over the course of the day. All things being equal, spreads would be centred around the current market price with a point in either direction built in to account for the broker’s commission. However, with dynamic quoting which changes spreads as markets unfold and built in weighting to reflect the probability of outcomes, it can often be quite difficult for traders to call the market correctly, and to squeeze a sufficient profit from their trading.
Spread Betting Concept
Financial spread betting might seem easy in concept, it is a notoriously difficult art to master, and one which requires both an intimate understanding of how transactions work, the function of markets and the tools in the arsenal to help traders respond to different situations. While there is no substitute for raw experience, having the knowledge and understanding of your instrument of choice is the first positive step towards becoming a profitable trader with long term prospects.
As distinct from regular share trading, spread betting has a number of key benefits, and offers consistent advantages over share dealing in terms of the sheer flexibility and the swift, sharp nature of returns that can be delivered. But it’s wise to remember that while it is popular, it remains a sub-niche of the overall trading industry, and many traders and investors of all sizes are unprepared or simply unable to accept the risks and the downsides it can bring.
Leverage in Financial Spread Betting
Leverage plays a key role, making transactions both significantly more profitable and significantly more risky, and the burden of leverage is not one to be accepted lightly. In spread betting, unlike other forms of trading, leverage is inevitable and unavoidable. However, by taking care to ensure you understand the full implications of each transaction, and by identifying and managing the risks of each trade, it is possible to overcome the hurdles of leverage, and to apply it to your advantage.
Markets are the engine of spread bets and all financial trading, and provide the basis for placing trades. The manner in which they behave and respond to certain changes provides the volatility necessary for financial spread trading to succeed, and by understanding their inner workings, traders can come a couple of steps closer to realising their potential. Similarly, orders remain the core tools of spread bettors, implementing their instructions and delivering the flexibility necessary to guard against unwarranted risks and execute automatic trading decisions conditional on market behaviours. By understanding the way in which markets and orders interact, and the specifics of each order type, we can start to build up a picture of how the tools of the trade can be used to protect capital, maximise profits and lower the risk profile on this otherwise highly risky trading style.
Financial spread betting can be an exciting, fast-moving form of trading, and allows ordinary people from all walks of life to access the markets with very low barriers to entry. That said, the markets take no prisoners, and only by being proactive in your research, planning and strategy efforts can you give yourself the best shot at generating a consistent, aggregate profit from your trading activity.
Making a Spread Bet
When making a financial spread bet, a trader will decide on a certain amount of money to risk. For example, say you want to bet £10 per point on a certain financial product because you think it will rise in value. If you’re right and the product increases its value by 20 points, you will make a total of £200 profit. However, while this might seem like the most simple of financial arrangements, it’s important to remember about the spread.
With any type of financial trade, you have to pay in order to play. Because the cost of the spread is factored into any trade, the broker is always at an advantage. Because the ask price is always above the current market price and the bid price is always below, traders have to pay the difference before they even enter the market. For this reason, even with an equal risk/reward scenario, you still need more than 50 percent of your trades to be successful in order to break even.
The current spread is based on a number of factors, including the current spot or futures rate, current market liquidity, the bet size, and spreads quoted by competing brokers. For anyone engaging in financial spread betting, it’s vital to pay attention to the spread and take it into account when setting up take profit and stop loss levels. At the end of the day, the size of the spread is set by the company you choose to trade with. While the house always makes money, it makes sense to research first in order to find a competitive broker with low spreads.
Simplified Spread Betting Example
To offer a more detailed example, if the FTSE 100 stands at 7000, the provider may offer you a bid price of 6999 and an offer price of 7001. If you are still dealing £10 per point on a long trade, you will only gain the above mentioned £200 after the index has risen to 7021. If the trade goes against you and sinks to 6979, you will lose £200. However, you pay the spread whether you win or lose, an important point that all traders should never forget.
Margin and Margin Calls
Because trades can quickly go either for or against you, firms require some sort of financial protection in the form of a ‘margin’. Typically around a few percent of the value of the underlying asset (margin can be much lower on popular markets), the margin is used by brokers as a way to ensure there is no risk of real loss. However, waiting for a margin call is a very bad way to trade, with most people setting up stop loss orders to close out trades at specific levels.
Orders and Execution
Normal orders are not 100 percent safe, however, especially when the market is moving so fast that lots of orders are triggered at the same time. Luckily, a number of companies offer guaranteed stop loss orders, where traders pay either a slightly higher spread or an extra fee as a way to insure themselves during times of high volatility. Stop loss orders are just as important as take profit orders, and the ratio between them is a significant part of all successful trading systems.
Spread Betting Pricing
Spread betting companies take ‘bets’, or more appropriately ‘positions’ in markets with dynamic pricing that responds as the market moves. The following illustration of spread betting pricing explains the basics of how spread betting transactions work.
The FTSE100 opens at 6000. Amidst increasingly positive economic indicators and a number of key announcements pending, you conclude that the FTSE will rise on the day, and want to enter into the spread market for it. At the point where the FTSE100 sits at 6000, your broker may quote pricing at 5999-6001. What does this mean?
The prices given reflect the buy and sell prices of the market. As you are looking for a rise in the FTSE, you want to ‘buy’ the market at 6001. This essentially means you are betting that the market will rise beyond 6001, at which point you can start to earn multiples of your stake.
If you believed the market was likely to fall, you would ‘sell’ at 5999. This means you start earning multiples of your stake when the market falls below 5999. The margin in the middle (in this instance 6001 minus 5999 = 2 points) represents the broker’s commission on the trade. This works because the market has to rise an additional couple of points to yield a profit, thus the broker earns a commission on your successful trade before it starts to earn those elusive multiples for you.
Because pricing is dynamic in response to the underlying movements of the market, it pays to be decisive and get in early. If the FTSE in the above example started to rise to 6001, the market would be adjusted accordingly, perhaps to 6000-6002, making it harder for you to squeeze a profit from the market. The sooner you respond, the greater opportunity you will have for making money from the transaction.
Spread betting markets are quoted on all manner of things, and are made up by the broker rather than being a publicly traded market. Because nothing physical is being bought or sold in a spread betting transaction, the market can occur between broker and trader directly, which brings with it accompanying UK tax advantages to trading in the spread markets rather than trading in the underlying markets directly. This, coupled with the leverage inherent in the structure of a spread betting transaction makes like-for-like investments in spread betting far more profitable (and risky) than their direct counterparts.
But aside from the sheer financial benefits of spread betting versus direct investing in the underlying markets concerned, spread betting also opens access to a wide variety of alternative markets, often covering markets and indices that simply can’t be traded directly. This delivers an additional helping of flexibility, which combines to make spread betting a more attractive investment prospect.
Much of the magic with spread betting comes down to managing leverage, researching markets and positions, and trading with a sensible, level head. While there are significant strategy components to profitable trading long-term, knowing what you’re doing and understanding the implications of certain trading decisions is the first and most central stepping stone to protecting your capital and delivering a solid return on investment.